Charles River Laboratories International, Inc. — Q2 2014 Form 10-Q
Business context and reporting period
Unaudited quarterly results for the three months ended June 28, 2014, and year-to-date results for the six months ended June 28, 2014, compared with periods ended June 29, 2013. Charles River is a global contract research organization providing research models and services, discovery and safety assessment, and manufacturing support. The company recast its reportable segments into these three categories; historical segment results were retrospectively presented, with no change to consolidated historical results.
Financial performance and liquidity
Amounts are in millions of dollars except per-share data. Percentages are year-over-year changes unless stated otherwise.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $341.2 | $292.9 | $640.5 | $584.2 |
| Operating income | $51.0 | $43.2 | $90.7 | $86.0 |
| Operating margin | 14.9% | 14.7% | 14.2% | 14.7% |
| Net income attributable to common shareholders | $35.3 | $27.3 | $67.5 | $52.9 |
| Diluted EPS | $0.74 | $0.56 | $1.41 | $1.09 |
| Operating cash flow | — | $85.4 | $78.9 |
- Q2 revenue increased 16.5%; the Early Discovery acquisition contributed $23.5 million, and foreign exchange added $4.2 million. Six-month revenue rose 9.6%, including $23.5 million from the acquisition and a $5.4 million foreign-exchange benefit.
- Q2 operating income increased 18.1%; six-month operating income rose 5.5%. The six-month operating margin declined from 14.7% to 14.2%, as higher corporate costs and RMS restructuring weighed on results.
- Six-month capital expenditures were $20.5 million, compared with $16.2 million. Cash used in investing activities was $202.5 million, primarily reflecting $183.2 million for acquisitions, net of cash acquired.
- Cash and cash equivalents were $117.0 million at June 28, down from $155.9 million at year-end 2013. Total debt was approximately $802.8 million, versus $663.0 million; the company reported compliance with all credit-facility financial covenants. Cash held by non-U.S. subsidiaries was $114.3 million and those earnings were described as indefinitely reinvested.
- Current assets were $592.7 million and current liabilities $271.6 million at quarter-end. The company repurchased $90.3 million of shares under its program in the first half; $48.8 million remained authorized.
Material changes and management commentary
- Early Discovery, comprising Argenta, BioFocus and certain Dutch assets, was acquired April 1 for a preliminary purchase price of $191.4 million, including contingent consideration. It added $23.5 million of Q2 revenue. VivoPath was also acquired in June for a preliminary $2.3 million, including contingent consideration.
- DSA and Manufacturing drove much of the growth. For the first half, segment revenue increased 18.4% in DSA and 15.2% in Manufacturing, while RMS revenue increased 0.4%. Management cited safety-assessment growth and demand for endotoxin-testing and microbial-detection products and services.
- Interest expense declined to $3.4 million in Q2 and $6.2 million for the first half, reflecting the prior-year retirement of senior convertible debentures. Other income included limited-partnership investment gains of $2.1 million in Q2 and $8.2 million for the first half; management warned these gains and losses may remain volatile and unpredictable.
- Six-month effective tax rate increased to 26.1% from 24.7%, reflecting tax-law changes and discrete tax costs, partly offset by a release of an uncertain tax position.
Outlook, risks and contingencies
- The filing provides no quantified full-year revenue or earnings guidance. Management expected investment-related other income or expense to remain volatile and unpredictable.
- Facility consolidation plans in Japan and North America resulted in accelerated depreciation and impairment charges. Management anticipated approximately $2.6 million of additional accelerated depreciation in the second half for the Japan plan and approximately $0.5 million more in 2014 for the Michigan facility closure.
- The company reserved $1.5 million for an investigation into inaccurate billing on certain government contracts and said additional losses were reasonably possible, but it could not estimate a range beyond the reserve. A supplier arbitration ruling ordered payment of $1.2 million plus arbitration costs and interest; the amounts of costs and interest were pending clarification.
- Interest-rate sensitivity analysis estimated that an unfavorable 100-basis-point rate change would add approximately $9.5 million of pretax interest expense over one year. Foreign-exchange exposure also remains, although no forward currency contracts were open at quarter-end.
- Unrecognized tax benefits increased by $18.9 million to $34.8 million, primarily due to pre-acquisition tax positions at Early Discovery. Management said it was reasonably possible up to $12.2 million, including interest, could decrease within twelve months. The company reported no material changes to the risk factors in its 2013 Form 10-K and stated that disclosure controls were effective.
Important facts for investors to verify
- How much of reported growth and future profitability is attributable to Early Discovery, and what integration costs or synergies remain?
- Whether acquisition-related debt, variable interest rates, cash held overseas and share repurchases affect liquidity and capital-allocation flexibility.
- The sustainability of limited-partnership investment gains and their contribution to reported pretax income.
- The eventual cost and resolution of the government-contract billing matter, supplier arbitration, and acquired-business tax positions.
- Whether consolidation charges, rising corporate SG&A and the lower first-half operating margin continue to affect earnings.